It has been doing its share of rounds in the global financial arena from some time, but it only took the global financial crisis to heighten the debate of anchoring the world?s monetary system on the greenback. As Dominique Strauss-Kahn, Managing Director, International Monetary Fund, in his recent visit to China announced that ?the yuan may be added in future to the basket currencies that set the value of special drawing rights (SDRs) and supported efforts to create a new global currency based on SDRs?, currency contours assumed a new shade.
Observers opine that the announcement by Strauss-Kahn not just spells a widening role of yuan in the global financial system, but also hints at how over the past 11 months, the world?s de facto reserve currency has started losing its sheen. The world has been over-relying on the dollar as a reserve currency, but the US in order to solve its own economic problems, has to print more money, which is devaluing its currency, explains Ajit Dayal, President, Quantum Asset Management Company. ?It is clear, that the economy of the reserve currency of the world is facing structural problems, which are serious and unsustainable, leading to worldwide concern, particularly at the policy level. The issues of low savings rate, the large current account deficit and the large budget deficit, are coupled with the question of how willing are those economies with surplus savings to continue financing these deficits,? Dayal shares.
?Renminbi or the Chinese yuan will have a wider role in global financial markets in years to come,? avers Jamal Mecklai, CEO, Mecklai Financial, ?Given that China will soon enough be the largest economy, there will have to be huge changes in the domestic Chinese forex market which will have significant implications for the Chinese economy at large. While this would normally be a very long term process, considering how undeveloped the domestic Chinese market currently is, everyone has learned that the Chinese are always able to surprise expectations!? He adds that the Chinese central bank is getting ready to let the yuan appreciate shortly; however, it is a long road from simply allowing the peg to move under supervision to being largely market determined.
A sentiment also echoed by Niru Yadav, Senior Research Associate, Centre for International Trade, Economics & Environment, Jaipur, ?Yuan is already cited as the third most important currency in the world by Robert Mundell and its use as trade settlement currency is likely to increase. Considering that China accounts for a substantial share of output and trade in the global economy, a currency that adequacy reflects its domestic conditions would certainly aid the global economy.?
Independent analyst Sitharam Gurumurthi corroborates that the world?s third largest economy that recently surpassed Germany as the largest exporting nation, is on its way to overtake Japan?s GNP by 2010 and that of the US by 2020. Gurumurthi adds, ?China has started encouraging the settlement of trade in yuan. It recently allowed companies in Shanghai and four other cities to take part in this pilot programme. This trade agreement is however limited to Hong Kong, Macau, and the Asean. These developments undeniably underline the expanding role for the yuan, at a time when Russia and emerging economies like India are seeking an alternate to the dollar.?
However, convertibility remains an issue for yuan, as DR Agarwal, Director, Institute of International Trade, Kolkata, points that even as China is allowing its select trade partners to use yuan as a medium of exchange by way of currency swaps, it can only be a solution for bilateral trade between China and the other trading partners. ?In order to become a currency of international reserve where a third country may keep a surplus in Chinese yuan, the first and foremost condition is convertibility, which is missing. Also, it can work only as long as the trade surplus is in favour of China. However, the moment the trade surplus goes in favour of the other country which has its obligation to pay for its import from the third countries in USD or in Euro, the same will not be acceptable. The other important issue is about the ultimate balance of payment. As long as China?s balance of payment remains positive and it continues to remain a surplus economy, it will have to keep its foreign exchange surplus in the currency of other countries, say either euro or sterling or dollar or yen or to some extent in SDR.?
Kalpesh Shah, CEO, investmentguruindia.com opines that the recent statements from various quarters on the issue by US President Barack Obama, Strauss-Kahn, Chinese authorities, is more due to political reasons, with each having different purpose. He adds, ?Managing yuan in a particular band vis-a-vis the USD is the core strategy of the Chinese government and it is very unlikely for it to change in near future for various macro economic reasons. As a growth strategy of Chinese economy, the idea is simple, to make sure that Chinese goods remain cheap and that Chinese factory workers remain employed, China needed to keep the dollar strong. To achieve this, China had two key strategies, prevent the yuan from becoming a freely-traded currency, in order to maintain government?and not free market?control over its exchange rate; and spend a large part of the proceeds from its export industries to purchase US Treasury Bills. In a nut- shell, China cannot get rid of its USDs, if China starts selling them, or even just stops buying them, their value will decrease, China now wants the world to come together and share its burden.?
The refusal of China to allow its currency to appreciate does not only affect the US, but several Asian economies like India whose currencies have been appreciating significantly since March 2009, affirms Gurumurthi. He adds, ?The value of the yuan which had been fixed at 8.28 yuan to US$1 since 1996 was changed to the current level of 6.83 yuan to US$1 from July 2008. This fixed exchange rate is protecting exporters from slumping demand. During the last one year, as a result of the weakening dollar, the trade-weighted value of the yuan has been pulled down, whereas currencies of several other countries have witnessed unprecedented appreciation. For example the Korean won and the Brazilian real have gained 36% and 42% against the yuan, making dents into the export prospects of these countries? .?
Nevertheless, if China were to have a more flexible currency regime, ?It would impact not only global trade competitiveness but also, more importantly, the efficiency of resource allocation in China itself, this will lead to substantially enhanced productivity in China, which will give world growth a definite boost,? confirms Mecklai.
?China?s track record is still work in progress?
He believes that the yaun being added in future to the basket currencies that set the value of SDRs spells not just a widening role of yuan but simply recognises China?s rising role in world trade and finance. Uri Dadush, Director, International Economics Program, Carnegie Endowment for International Peace, explains to Sarika Malhotra, ?Even as China will be the world?s largest trading nation within a few years, the dollar will remain the world?s leading reserve currency in the foreseeable future.? Excerpts:
Given that the addition in the basket of currencies will depend on the value of the renminbi being set by the market forces; do we see it happening in the near future?
This may be desirable, and I believe, along with many others, that the yuan left to itself would appreciate, and that if it did, would be in China?s best interest. If the yuan was floating, Chinese authorities could use orthodox monetary policy more freely to address domestic imbalances instead of resorting to highly distortive administrative measures. However, there is a strong resistance among China?s leaders to allow the yuan to fluctuate and find its value, perhaps reflecting concerns about stability, export lobbies or a mercantilist mentality or all of the above. In any event, I am reluctant to predict a big change in regime soon, though I expect the yuan to be allowed to revalue again once the crisis is past.
What stops the yuan from being a major reserve currency?
The list is long? including limited convertibility, capital account restrictions, shallow capital markets, and lingering concerns ? justified or not – about the durability of China?s political; system as we know it today. Essentially, you would like to keep your assets in a currency and a system that allows you easy entry and exit, and that has a long track record of stability, and China?s track record is still work in progress.
Do you agree with Barack Obama?s recent statement that a Chinese currency that reflected ?economic fundamentals? would aid the global economy?
Yes, I agree. It would reduce protectionist pressures. Most of all though, it would help China rebalance its economy from excessive and inefficient investment to consumption. Ironically, a stronger yuan would do little for the US, as its deficit is due to much deeper domestic issues in the US.
Is the world on its way for a new global currency?
No. I believe the current system will persist in the foreseeable future, with perhaps a little more euro, a little more SDRs, and even a little more yuan in China?s neighbourhood, and a little less dollar. But the dollar will remain firmly in the lead.
What role will euro play in the changing dynamics?
The euro is the only viable alternative to the dollar today especially in the EU neighbourhood, and, on balance, appears to have navigated a historic crisis successfully. However, the euro is also still a young currency, work-in-progress, and there are still concerns ? justified or not – that some of the less competitive euro?area economies may one day buckle under the pressure of a currency that is too strong for them and that may be retarding their growth. European capital markets are still too fragmented and individually too shallow to compete with the US. You prefer to hold your assets in an economy that is large, fully integrated, and has a common regulatory framework, a foreign and security policy; Europe is still a way from that.
Can SDRs be the new global currency? Will SDRs play a bigger role in the world financial systems, with China, Russia and India calling for replacing the dollar as the main reserve currency after the financial crisis?
I doubt it. In the end, the SDR is a claim on the shareholders of the IMF, ie. the International Community ? I doubt that there is enough trust in each other, and enough trust in the IMF as an institution? even though it plays a crucial role ? for nations to rely on an International Community Currency (ICC). I also strongly suspect that the US prefers to trade in dollars, and the EU in euros than in SDRs/ ICCs. As the biggest IMF shareholders, the US and Europeans will be on the hook each time new SDRs are issued, and they may not want to leave those decisions to majority voting (though the US has an effective veto, which is another issue that reduces the attractiveness of SDRs in the eyes of other countries).
But, SDRs is enjoying a renaissance after falling into near oblivion for decades. What accounts for this?
A massive financial crisis that originated in the US, and shook the faith in its system to its foundations. Also, the large new issue of SDR which was agreed during the crisis, when a real possibility existed that a simultaneous run on several exposed countries would draw the world economy into the abyss. But the world economy has survived and is growing again, and, remarkably, the US remained a safe haven as the crisis unfolded.
Special Drawing Rights
SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries? official reserves. Its value is based on a basket of four key international currencies: US dollar, euro, yen, and pound; SDRs can be exchanged for freely usable currencies. Following a special allocation on
September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to SDR 204.1 billion (currently equivalent to about $324 billion). The determination of the currencies in the SDR basket and their amount is made by the IMF Executive Board every five years.
The next review will take place in 2010.
The SDR is neither a currency, nor a claim on the IMF; it is a potential claim on the freely usable currencies of IMF members. 100.00 XDR = 158.251 USD. Holders of SDRs can also obtain these currencies through the arrangement of voluntary exchanges between members. SDR, serves as the unit of account of the IMF and other international organisations.